Utilities-03-Dividend growth investing

Investing into utilities for the average dividend growth investor

Series introduction – looking at utilities for dividend growth investing

I like utilities. We all need them. They are not going to disappear. They often pay high dividends and represent a good source of income and possible low but steady returns. They are NOT a bond replacement, in my mind, as they retain significant price fluctuations and can reach overvaluations and, conversely, under valuations which is when I become interested in them. Utilities will always be a core part of my approach to investing as they can be slow but steady compounders and fit the strategy.

In this series, we will step through a number of options in this space:

PEG – a good utility for the average dividend growth investor

Public Service Enterprise Group has a long history in the NJ region of USA and is the largest electric and gas utility there. They also have nuclear generating assets and has been part of the Dow Jones Sustainability Index for 14 years.

Dividends

I never get particularly excited about utilities and their growth opportunities or even their dividends. I see them like eating my greens – they are good to have and serve a particular purpose!

At present, the yield is approximately 3.44% but with the added benefit of slow-and-steady increases of the 4% magnitude over time. This does not keep pace with current inflation rates but would, under more normal circumstances seen in the last several years, represent a growing stream of income in ‘real’ terms.

Valuation and the importance in dividend growth investing

This stock presently trades at a 17.64x PE. This is high – for most stocks under most circumstances. It certainly is high for a firm with limited expectations for long-term growth. The current analysts’ expectations are for 4.5% pa growth for the next five years. This is hardly enough to make me excited. Is it enough to bank on? Well, the analysts tend to be more-or-less spot-on with their estimates over a one- and two-year estimation period, so this does look reasonable when looking at dividend growth investing.

PEG-2022-07-near-term forecast-dividend growth investing
Figure 2. PEG with an optimistic near-term forecast-dividend growth investing-assuming no contraction of the PE ratio. Source: Historical Graph – Copyright © 2011-2022, F.A.S.T. Graphs™ – All Rights Reserved

If the recent PE ratio is maintained and the near-term expectations for earnings growth are met, this would result in a 7.15% RoR pa until the end of 2024 (Figure 1). Is that reasonable at such a high PE to start with in an environment with rising interest rates? Personally, this would represent a reasonable level of risk to me.

If we use FAST graphs to examine what happens if there is a contraction in the PE ratio (prices decline with the same level of earnings) we get the calculations shown in Figure 2.

PEG-2022-07-near-term forecast-dividend growth investing
Figure 2. PEG with a reasonable and realistic near-term forecast-dividend growth investing. Source: Historical Graph – Copyright © 2011-2022, F.A.S.T. Graphs™ – All Rights Reserved

If I take a 14.6x PE ratio (using the GDF), then by the end of 2024 I might squeak through with a  0.6% RoR pa (Figure 2). This, in my mind, is a more likely and conservative estimate of what I may earn from this investment if I were to invest at the current prices.

As a final note, with either Figure 1 or Figure 2, check the analyst estimates. They are steady. This is what I like to see as a dividend growth investor!

Prospects

My estimation is that the PE will contract tin coming years to a more reasonable 12-15x PE. Even at the upper end, as I note, this would represent no significant growth for me if I were to invest today in my dividend growth investing portfolio.

Thesis

The stock is a solid stock with an great history of meeting analyst expectations for earnings growth. The earnings growth are relatively slow or sluggish and the dividend is not high and not increasing much. That’s ok – it is about what I expect for most utilities for dividend growth investing.

However, the current PE ratio is higher than I would like to see and my expectation for a PE contraction (decrease) in the coming years means that there is no margin of safety here.

As a consequence, I would rate this as a solid HOLD – keep it if you have it in the portfolio but do not rush out and buy at this price.

A more reasonable price may be about $50, compared to the current 62.80. This is a steep decline but it would provide some security against lower moves and provide for reasonable investment returns in the future.

Series introduction – looking at utilities for dividend growth investing I like utilities. We all need them. They are not going to disappear. They often pay high dividends and represent a good source of income and possible low but steady returns. They are NOT a bond replacement, in my mind, as they retain significant price…

Series introduction – looking at utilities for dividend growth investing I like utilities. We all need them. They are not going to disappear. They often pay high dividends and represent a good source of income and possible low but steady returns. They are NOT a bond replacement, in my mind, as they retain significant price…

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